You are going to love this lesson. Using pivot points as a trading
strategy has been around for a long time and was originally used by floor
traders. This was a nice simple way for floor traders to have some idea of
where the market was heading during the course of the day with only a few
The pivot point is the level at which the market direction changes for the
day. Using some simple arithmetic and the previous days high, low and
close, a series of points are derived. These points can be critical
support and resistance levels. The pivot level, support and resistance
levels calculated from that are collectively known as pivot levels.
Every day the market you are following has an open, high, low and a close
for the day (some markets like forex are 24 hours but generally use 5pm
EST as the open and close). This information basically contains all the
data you need to use pivot points.
The reason pivot points are so popular is that they are predictive as
opposed to lagging. You use the information of the previous day to
calculate potential turning points for the day you are about to trade
Because so many traders follow pivot points you will often find that the
market reacts at these levels. This give you an opportunity to trade.
the market opens above the pivot point then the bias for the day is long
trades. If the market opens below the pivot point then the bias for the
day is for short trades.
The three most important pivot points are R1, S1 and the actual pivot
The general idea behind trading pivot points are to look for a reversal or
break of R1 or S1. By the time the market reaches R2,R3 or S2,S3 the
market will already be overbought or oversold and these levels should be
used for exits rather than entries.
A perfect set would be for the market to open above the pivot level and
then stall slightly at R1 then go on to R2. You would enter on a break of
R1 with a target of R2 and if the market was really strong close half at
R2 and target R3 with the remainder of your position.
Unfortunately life is not that simple and we have to deal with each
trading day the best way we can.
I have picked a day at random from last week and what follows are some
ideas on how you could have traded that day using pivot points.
12th August 04 the Euro/Dollar (EUR/USD) had the following:
Low - 1.2213
Close - 1.2249
This gave us:
Resistance 3 = 1.2377
Resistance 2 = 1.2337
Resistance 1 = 1.2293
Pivot Point = 1.2253
Support 1 = 1.2209
Support 2 = 1.2169
Support 3 = 1.2125
Have a look at the 5
minute chart below
green line is the pivot point. The blue lines are resistance levels R1,R2
and R3. The red lines are support levels S1,S2 and S3.
There are loads of ways to trade this day using pivot points but I shall
walk you through a few of them and discuss why some are good in certain
situations and why some are bad.
The Pullback Trade
This is one of my favorite set ups. The market passes through S1 and then
pulls back. An entry order is placed below support, which in this case was
the most recent low before the pullback. A stop is then placed above the
pullback (the most recent high - peak) and a target set for S2. The
problem again, on this day was that the target of S2 was to close, and the
market never took out the previous support, which tells us that, the
market sentiment is beginning to change.
Breakout of Resistance
As the day progressed, the market started heading back up to S1 and formed
a channel (congestion area). This is another good set up for a trade. An
entry order is placed just above the upper channel line, with a stop just
below the lower channel line and the first target would be the pivot line.
If you where trading more than one position, then you would close out half
your position as the market approaches the pivot line, tighten your stop
and then watch market action at that level. As it happened, the market
never stopped and your second target then became R1. This was also easily
achieved and I would have closed out the rest of the position at that
As I mentioned earlier, there are lots of ways to trade with pivot points.
A more advanced method is to use the cross of two moving averages as a
confirmation of a breakout. You can even use combinations of indicators to
help you make a decision. It might be the cross of two averages and also
MACD must be in buy mode. Mess around with a few of your favorite
indicators but remember the signal is a break of a level and the
indicators are just confirmation.
We haven't even got into patterns around pivot levels or failures but that
is not the point of this lesson. I just want to introduce another possible
way for you to trade.